Research On RMB’s Foreign Exchange Rate Pass-Through Into China’s Export And Import Prices

Foreign Exchange Rate, as the price for an economy’s currency, is the keyvariable for its internal and external balance adjustment. Foreign Exchange Ratefluctuations directly change an economy’s relative export prices to the import prices,which, through the Expenditure Switching Effect, leads to the adjustment of tradebalance and further of the country’s general price level.Since2005in which reform for the formation mechanism of RMB’s ForeignExchange Rate has been more market-oriented, Both the Nominal and Real EffectiveExchange Rate of RMB have been rising continuously and sharply. According to theclassic trade balance theory, this will result in relative export prices adjustment withimport prices denominated in local currency decrease and export prices in foreigncurrency increase and thus depressing exports and encouraging imports which throughthe Expenditure Switching Effect, reducing China’s huge trade surplus and improvingChina’s internal and external imbalance. But facts contradict the theory. China’s tradesurplus increased sharply from$31.98billion in2004to$101.88billion in2005andsince then China’s trade surplus has been experiencing rapid growth in large-scale.There really is the paradox of trade surplus accumulation with RMB appreciation whichthis dissertation tries to explain from the view of Foreign Exchange Rate Pass-Through.To explain the paradox, first the dissertation makes a literature and theory surveyof the Foreign Exchange Rate Pass-Through. Second reviewing the analytical frame forthe relationship of Foreign Exchange Rate, relative export prices and the trade balanceadjustment in open macroeconomics, the dissertation bases its analytical frame on theNew Open Economy Macroeconomics. Third facts and figures on the statistical trend ofRMB Foreign Exchange Rate, China’s export and import prices and China’s tradebalances are analyzed describing further the paradox. Fourth the dissertation estimatesthe RBM’s exchange rate pass-through rate into China’s export prices at aggregate andindustry levels respectively basing on bilateral approach. Fifth the dissertation focuseson the variation of RBM’s exchange rate pass-through rate into China’s export pricesacross country and industries on multilateral estimation and highly disaggregated data.Sixth RBM’s exchange rate pass-through rate into China’s import prices is estimatedusing the bilateral approach. Seventh, basing on the experimental estimation resultsfrom Chapter5to7, the dissertation discusses the relationship between incomplete Exchange Rate Pass Through and the tendency of China’s Terms of Trade explaining theparadox of trade surplus accumulation with the continuing deterioration of China’s TOT.Finally Chapter9provides insights for the internal-external balances adjustmentpolicies.The conclusions of the dissertation are as follows:First aggregately the dynamics of RBM’s exchange rate pass-through rate intoChina’s export prices are almost complete3months after the RMB exchange ratechange, and then fall gradually to0.431year later. The dynamics of RBM’s exchangerate pass-through rate into China’s import prices are approaching complete. The obviousPricing-to-Market behavior in China’s export weakens the Expenditure Switching Effectby half.At the industry level, the main resources for China’s trade surplus are SITC7(machinery and transport equipment) and SITC8(labor intensive products).Pricing-to-Market coefficients for these two industries are over0.7thus weakening theExpenditure Switching Effect by70%considering the complete exchange ratepass-through rate into China’s import prices.The US is the main country resource for China’s trade surplus andPricing-to-Market coefficient is the highest among China’s main trade partnersweakening the Expenditure Switching Effect by50%considering the completeexchange rate pass-through rate into China’s import prices from the US. In bilateraltrade between China and Japan, RBM’s exchange rate pass-through rate into China’sexport prices to Japan and import price from Japan are both incomplete and almostequal (0.7).There are two chains from the fluctuation of Foreign Exchange Rate to theadjustment of the trade surplus: first the relative export price e.g. the Terms of Tradeadjusts with the change of Foreign Exchange Rate and then through the ExpenditureSwitching Effect, the Change of TOT influences an Economy’s trade surplus. Howeverfrom2005to2007, continuous appreciation of RMB has been accompanying withcontinuous deterioration of TOT because other demand and supply factors in domesticand international markets reverse the Expenditure Switching Effect besides incompleteExchange Pass Through weakening it seriously. On one hand, the increase of the exportprices is limited because of the weak bargaining power of China’s exporters and therestructuring of the exporting commodity; On the other hand, investment-driven importdemand for energy and raw materials push sharply China’s importing prices. The rapid growth of large scale trade surplus between2005and2007is the result of both theinternal and external supply-demand factors. It will be hard for China to see the furthergrowth of trade surplus with the continuous deterioration of TOT and decreasing ofexternal demand since the global financial crisis in2008.Conclusively the dissertation explains the paradox of trade surplus accumulationwith RMB appreciation form Exchange Rate Pass-Through and provides new insightsfor our internal-external imbalance adjustment policy makingFirst it must be stressed that under the background of USD as the maininternational reserve currency, the Foreign Exchange Rate of RMB is absolutely not thekey to the global rebalance. Without US and China’s efforts to restructure theireconomies, it is impossible to solve the problem of global imbalance. Secondly, inshort-run, the fundamental principle for China’s Foreign Exchange Rate and tradebalance policies should keep RMB stable and avoid sharp appreciation to ensure thegrowth of trade and GDP. At the same time, the government should make the RMBconvertible under capital accounts gradually and cautiously. Thirdly the core of China’strade policies should be improving the bargaining power of Chinese importers andexporters. Finally Considering the internal and external adjustments are not cyclical butstructural, China’s future growth must depend on domestic demand.For macroeconomic internal and external balance, RMB’s Foreign Exchange Rateis far away from the key. The Elasticity analysis deals Foreign Exchange Rate under thepartial equilibrium frame which is actually a typical general equilibrium problem.Reform instead of appreciation of RMB is the key for China’s macroeconomic balanceproblems.